Are you in the Zone? Additional Duties Imposed on Directors of a Corporation in the “Zone of Insolvency”

• Posted by Geoffrey G. Gussis on September 20th, 2005


• Filed in Corporate/M&A

Keith C. Owens and Donald A. Workman (Foley & Lardner LLP) provide guidance on the additional duties of directors of companies that have entered the "zone of insolvency" - an area of jurisprudence that has continued to develop throughout the United States legal system over the past few years:

"Directors of a public or private corporation know very well that they serve in a fiduciary capacity to shareholders of the corporation and must, at all times, fulfill duties of care, loyalty, and good faith for the benefit of the corporation and its shareholders. In most instances, a director’s fiduciary obligations begin and end with the shareholders.

The obligations shift once a corporation becomes insolvent and their fiduciary duties extend to the creditors of the corporation. Courts reason that once the corporation becomes insolvent, or enters the "vicinity of insolvency," the corporate assets are held in trust for the benefit of creditors, causing the directors to become trustees with a fiduciary duty the creditors. The economic rationale for the "insolvency exception," also known as the "trust fund doctrine" or the "zone of insolvency," is that the value of creditors’ contract claims against an insolvent corporation may be affected by the directors’ business decisions.

The fiduciary duty owed by a director or controlling shareholder of an insolvent corporation requires that the controlling shareholder/director of the debtor maximize the value of the assets for unsecured creditors. Directors or officers of an insolvent corporation may be held strictly accountable or liable to the general creditors if the corporate funds or property are wasted or mismanaged."

Link: Foley & Lardner - United States - Are you in the Zone? Additional Duties
Imposed on Directors of a Corporation in the "Zone of Insolvency" from Mondaq (free registration required).